Generally speaking if you have a debt cancellation you can expect income. So if you don’t pay your credit card debt, the credit card company will send you a 1099 for the amount of debt cancelled as though it is income you have earned. That income must be included in your tax for the year. The same thing occurred with mortgage cancellation of debt until pressure came from taxpayers years ago and congress responded by giving reprieve to mortgage cancellation of debts. But like everything else given by the government, you are extracting skin over a bone. It is painfully given. In other words there will be strings attached. Strings or no strings the change was a very welcome.

Which Debt Qualifies for Debt Forgiveness?

Debt is forgiven if it is occasioned by loans on your home and the maximum loan is two million dollars (one million for married filing separately).

If you have debt restructuring you may be able to exclude the amount of debt reduced (or forgiven) as a result of the debt restructure. The same thing also applies to foreclosure. If the debt that is forgiven was prompted by foreclosure on your home that debt also is not taxable. Remember that this does not apply to investment property.

The rules also apply to loans resulting from financing. This will only be applicable if you use the loan proceeds to build or make major improvements in your home. This exclusion applies only to the underlying original loan on your home that you had before refinancing. If you refinance your home for purposes other than what is listed above such as refinancing your home to pay credit card debt or even an IRS debt or back taxes, this will not qualify for the exclusion.

If you are a candidate for the exclusion, use form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness. This form should accompany your tax return in the year of debt cancellation.

Again other debt cancellation may not be subject to the exclusion. Cancelled debts on second homes, rental business property, credit cards, and car loans do not qualify for this exclusion. You may qualify for the discharge best on other procedures or rules such as bankruptcy and liquidity problems.

You will receive form 1099- Cancellation of Debt, which shows both debt forgiven and the fair market value of the property subject to debt cancellation or foreclosure.

Dean Alexander has been helping clients across the country with tax issues for over 30 years. He currently is the president of NFA Tax Help located in Houston, TX. Their website is www.resolvemytaxes.com.